@MartinSLewis America has reached a total national debt of 14.3 trillion. They only asked Wonga for £200.”

It was meant as a joke, but it then occurred to me to try to do the maths and see how long it would actually take to reach that amount .

The maths behind it

The payday loan company has a 4,214% representative APR. That means if you were able to borrow money from it, without repaying for a year, you’d owe just over 42 times the original amount.

Now at this point, I need point out this shocking stat which bears little resemblence to reality. You CANNOT borrow for a year with Wonga, its a short term lender. In fact the APR is a pretty irrelevant stat when it comes to payday loans in general (see below for why) and Wonga specifically (as it doesn’t compound its daily rate) so do take this with a lump of salt.

Yet the numbers are too salacious to avoid doing. If you could get a loan term loan at this rate, and it compounded over a longer period, here’s what’d happen…

Borrow £100 and make no repayments

After 1 year

Owe £4,200

After 2 years

Owe £180,000

After 3 years

Owe £7,500,000 (£7 million)

After 4 years

Owe £315,000,000 (£315 million)

After 5 years

Owe £13,000,000,000 (£13 billion)

After 6 years

Owe £557,000,000,000 (£557 billion)

After 7 years

Owe £23,500,000,000,000 (£23.5 trillion)

In other words, in less than six years you’d owe more than the entire US national debt (which is just £10 trillion so less than half).

Why APRs are bonkers for payday loans

These loans are short term loans usually lent for weeks or a couple of months (with Wonga its 31 days capped – hence why I title this ‘at Wongas APR’ not ‘borrowing from Wonga’), not years, and for small amounts.

Over a short term APRs are often irrelevant, after all if you borrowed £20 and paid someone back and bought them a pint (£3) the next week, that sounds pretty reasonable. Yet if you were to take it as a loan, and compound it, it’d signify a 143,000% APR – far more than Wonga’s APR.

This is a problem as it means the cost of lending simply isn’t transparent from the APR (see Should we worry more about 10% interest than 2,000%) and why I don’t favour capping interest rates, but think its the total cost of borrowing we need to regulate.

The real reason payday loans can be so dangerous

Yet just because the calculations above isn’t realistic, it is important.

The reason for doing this shocking illustration is that what really frightens me about the payday lending as a whole is it’s so easy, it can be done without thought and on impulse – just by the click of a mouse. So any form of shock tactic is a good one.

In a controlled environment over a short period, payday lending can meet an unfortunate need, and are certainly better than illegal loan sharks – and sometimes far cheaper than bank charges.

Yet the real worry is some companies let these debts roll over (ie, a lender says "don’t pay us back now, keep the cash, we’ll just add it on",) and its then that compound interest really does start to hit – even if just extending over just a few weeks. Even if companies don’t allow roll over, people still end up using one payday lender to pay off another – effectively rolling over.

Hopefully letting people see a little bit of hyperbole about the sexiest brand in the industry – may make them think twice before getting payday borrowing.

It’s another reason I hope people sign the get financial education on the curriculum petition to the PM. PS. One of the first responses on my facebook page to this blog was the following – which is exactly why I wrote it, “My 18 year old daughter borrowed £76 from a payday lender she now owes £900…they make it too easy 4 kids 2 get in2 debt!! Should raise the age 2 at least 21!!”

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